At that time, the LinkedIn IPO was only three months old and many were wondering how a company with on profits of $15M would sustain itself. The stock price has ranged from $55.98 to $120.70 with a current close price of $90.67 (as of 3/12/12). The original valuation after the IPO was $9B. Another recent IPO, Yelp, which entered the market at $19.36 still hasn’t risen above $22.49. Groupon is another example of a recent IPO that opened at 14.85, saw a high of $31.14 and is currently trading at $17.06. Hopefully, we’ve learned since those frothy days when any company that had a “.com” append was immediately valued at 100 times its burn-rate. But the real question we should be asking is “Is there a substantial and sustainable business model behind the company in which I’m investing?”
Between 1970 and 1990, there were 4,753 IPOs in the US. Of those, 20 percent did worse than a random selection of existing stocks. Is the situation today much different than that time period? Certainly the types of businesses issuing are more weighted toward technology than forty years ago. Inflation in 1999 was 2.2 percent. The unadjusted percentage change between January 2011 and January 2012 was 2.9 percent. The problem is that with rising gasoline and other commodity prices, very few people will actually believe that metric. So based on all of the inflation that’s taken place over the past 13 years, the resulting loss in monetary valuation, the current pressures on the economy, including the looming European recession, the European sovereign debt crisis and the unsustainable US debt, will the next batch of IPOs, especially Facebook, cause another meltdown?
In a recent article on Motley Fool (http://www.fool.com/investing/general/2012/02/02/facebook-ipo-tech-bubble-20.aspx), that is exactly what’s being postulated: that Facebook’s IPO could instigate the tech bubble 2.0. Because the expected valuation of the stock will range from $75 to $100 billion, one of the largest IPOs in US history, but its operating margin is comparatively slim to other technology companies and it has no real products. The real concern is, if the IPO does fail, whether there will be collateral damage to other technology stocks such as Apple, Intel, BCE, Vivo Participacoes, American Tower, Altera, Analog Devices, SanDisk, Cerner and OYO Geospace, to name just a few that could be affected.
In a CNN Money posting of March 8, 2012 (http://finance.fortune.cnn.com/2012/03/08/tech-ipos-are-back-now-what/), Lee Hower took a slightly more rational position based on four key points. In spite of the current batch of economic challenges and the delays that caused with issues like Zynga and Groupon, “the macro economic conditions are comparatively calm.” He also cites that the U.S. economy, though still in a weak recovery mode actually has good fundamentals and is continuing to progress. We’ve seen substantiation of this with the latest employment numbers. So point number one, the macro environment still dictates IPO windows.
For the most part, the companies that are attempting IPOs are those that have viable business models (or they appear to be viable) of a meaningful scale. Benchmarks for this point, that the bar remains high, include $50M in trailing sales and a run rate near or above $100M. Top line growth plays a large part in the underwriting process as well. A $50M business that is doubling every year is in a good position as opposed to a $50M business that is growing at 10-20 percent annually that will struggle to go public. Finally, margins matter as well. To go public will require a high gross margin and low customer acquisition costs.
Mr. Hower also makes a good point that public markets distinguish strong from weak. It takes investors 6 – 12 months to get comfortable with a new issue and these investors are distinguishing between companies based on a variety of other specific factors related to each individual company.
Finally, post IPO consistency is as important as ever. No brainer, right? Company revenue and profitability is essential and if this can’t be reasonably projected, then it’s probably a better strategy to stay private. One good example of this cited by Mr. Hower was Pandora, which stock priced dropped 25 percent below the original IPO price of $16 after the Q42011 earnings announcement.
So what’s the conclusion? I don’t know if anyone’s crystal ball is clear enough to predict whether or not we’ll see a meltdown in the near future. Frankly, I’m hoping for a more optimistic outcome. The more IT and other technology companies that prosper, the more data center space and services will be needed and, even though the data center sector isn’t one of the larger employer sectors, the companies using data center space, colocation, managed- and cloud-services will create momentum to keep the economy on a growth trajectory.